MARKETS ANTICIPATE EUROZONE RATES MAY FALL EVEN FURTHER

LAST week the European Central Bank (ECB) left its monetary policy unchanged, stating that the current 1 per cent repo rate is appropriate. But the currency market may think differently. For the past several months pricing pressures in the Eurozone have been practically non-existent. Consumer inflation has been at zero for the past two months, while producer prices have contracted for eight consecutive months. In Germany, goods prices are falling at record pace while Commerzbank predicts that real wages will contract this year. Deflation – not inflation – is more pressing.

The ECB is adamantly maintaining a relatively restrictive monetary policy. However, the ECB could be jeopardising the region’s fragile recovery by keeping rates too high for too long.

The ECB’s recent unlimited one-year-term auction resulted in nearly a half-trillion euros of loans to the banking sector, but €300bn of it went right back in the central banks’ ledgers as deposits – a dynamic that’s likely to continue as long as ECB deposit rates remain positive.

Little wonder that German finance minister Peer Steinbrueck is frustrated that banks are speculating rather than loaning the money to businesses. If the Eurozone recovery begins to stall in the second half, the ECB may be forced to belatedly lower rates beyond 1 per cent. The currency markets may already be anticipating this move as the euro drifts further from its yearly highs.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail BorisandKathy@gftuk.com.